What it means
A borrower who pays one point on a $300,000 loan pays $3,000 at closing. In return, the lender typically offers a lower interest rate for the life of the loan.
The exact rate reduction varies by lender and market, so borrowers should ask for it in writing. The decision comes down to time.
Points cost cash today and save money every month afterwards, so they only pay off if the borrower keeps the loan long enough to recover the upfront cost. This is called the break-even period.
Borrowers who expect to sell the home or refinance within a few years often do better paying no points and accepting a higher rate. Borrowers who plan to stay for a long time and have spare cash may gain by paying them.
There are also tax and accounting angles. In some countries, mortgage points on a main home may be deductible as interest, but the rules vary and change, so a tax adviser should confirm the treatment.
Business borrowers may need to spread the cost over the loan's life instead of expensing it immediately. Some lenders also offer the reverse: a higher interest rate in exchange for a credit that reduces closing costs.
Comparing offers needs a like-for-like look at both the upfront cash and the monthly payment. Points also change how lenders and borrowers compare offers.
The annual percentage rate (APR), which folds fees into a single yearly cost figure, helps show whether a loan with points is really cheaper than one without. Always compare the APR and the break-even period, not only the headline rate.
In practice
Real-world examples.
Example
A young family buying their first home plan to stay at least ten years. They pay one point on a $350,000 loan, which costs $3,500, and expect to recover it within about three years of lower payments. After that point, the saving is a real gain every month for as long as they hold the loan.
Example
A consultant who relocates often takes a mortgage and pays no points. The higher rate costs a little more each month, but there is no large cash outlay that would be lost on a quick sale. This keeps the consultant's cash free for the next move.
Example
A small business owner buying an office building negotiates two points with the bank to secure a lower rate on a $1,000,000 loan. The accountant spreads the $20,000 cost over the loan term in the books. This matches the cost with the years in which the lower rate benefits the business.
Formula
Calculation
Cost of points = loan amount x number of points x 1%
Break-even months = cost of points / monthly saving
Suppose a borrower takes a $400,000 loan and pays 2 points.
Cost of points = 400,000 x 2 x 0.01 = $8,000.
If the lower rate reduces the monthly payment by $200, break-even months = 8,000 / 200 = 40 months.
The borrower recovers the cost after 40 months, a little over 3 years. After that, the $200 monthly saving is a real gain, but selling or refinancing before month 40 would leave the borrower worse off. Over a full 360-month loan, the total saving would be 200 x 360 = $72,000 against the $8,000 cost.Case study
Seen in the real world.
Northgate Dental is a fictional clinic buying its premises with a $600,000 loan. The bank offers two options: a rate with no points, or a lower rate with 1.5 points. The owner asks the finance manager to run an illustrative comparison before deciding.
The points option costs 600,000 x 1.5% = $9,000 upfront and reduces monthly payments by $150. The break-even is therefore 9,000 / 150 = 60 months, or five years.
The owner expects to remain in the building for at least fifteen years, so the points option wins comfortably, with the clinic saving well over the upfront cost in the later years. The manager adds the $9,000 to the cash budget for the closing month and records the cost as a financing expense to be spread over time.
Watch out
Common mistakes.
- Paying points without calculating break-even. The saving only exists if the borrower stays in the loan long enough.
- Confusing points with the interest rate. A point is a one-time fee paid at closing, while the rate is an ongoing cost that shows up in every monthly payment.
- Assuming every lender gives the same rate reduction per point. Offers differ, so compare them in writing.
Questions
People also ask.
What is one point worth?
One point equals 1% of the loan amount, so a $250,000 loan has a point worth $2,500, and two points would cost $5,000 at closing.
Are points the same as closing costs?
No. Points are one part of closing costs, which also include legal, valuation and administration fees, so a quote showing only the points does not give the full cash needed on the day.
Are points negotiable?
Often yes. Origination points in particular can vary between lenders, so it pays to collect written quotes from at least three before choosing.
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